President Obama has released his “Greenbook” budget proposal for fiscal year 2017. It renews a number of items from past budget proposals. The Republican Congress will disagree with many of the proposals based on statements from Republican leaders in both the Senate and the House. Certain broad subjects may offer a chance for compromise, especially in the area of corporate tax reform. Others are “dead on arrival” as some Republicans have already stated in the media. Chances are that tax gridlock will continue in Washington during the election year of 2016 as the Obama budget proposal and the Republican Congress appear to be far apart politically.
Here is a summary of the 2017 budget proposals that would have an effect on income taxes, estate planning, and retirement planning:
Income Taxes and Capital Gains Taxes
- •The Administration proposes to reduce to 28% the value of certain deductions for taxpayers in the 33% bracket or higher. This would affect (1) all itemized deductions (2) any tax exempt bond interest (3) health insurance costs of self-employed individuals (4) employee contributions to defined contribution retirement plans and IRAs.
- •An increase in the top long term capital gains and qualified dividends rate from 20% to 24.2%. Combined with the current 3.8% tax for certain high earners on passive income, this would increase the top effective rate to 28%.
- •The proposal seeks to limit the exceptions to the transfer for value rule for transfers of life insurance policies. This may cause part of the death benefit to be taxable income. For a transfer to a partner of the insured, a transfer to a partnership in which the insured is a partner, and a transfer to a corporation in which the insured is a shareholder, the exceptions to the transfer for value rule would apply only if the insured is a 20% or more owner in a partnership or a corporation. LLCs are considered to be partnerships for purposes of the transfer for value rule.
- •The budget proposal would impose new reporting requirements for sales of insurance policies to life settlement companies with death benefits of $500,000 or more. Upon sale, the buyer would be required to report the purchase price, the buyer and seller’s identity, and the insurance carrier and policy number to: (1) the IRS (2) the insurance carrier and (3) the seller.
Estate and Gift Taxes
- •The proposal would permanently reinstate the 2009 estate and gift tax exemptions and rates (i.e. 45% estate and gift tax rate, $3.5 million estate tax exemption, and $1 million gift tax exemption). Portability of the estate tax exemption between spouses would continue.
- •Coordinate income and estate tax rules for grantor trusts. In effect, if a trust was a grantor trust for income tax purposes, the value of the trust assets would be included in the gross estate for estate tax purposes. Irrevocable life insurance trusts would have to be structured as non-grantor trusts to avoid having the death benefit included in the gross estate.
- •Require Grantor Retained Annuity Trusts (GRATs) to have a 10 year minimum term and a minimum remainder value equal to the greater of 25% of the value of the assets placed into the GRAT or $500,000. This would eliminate the use of short term rolling GRATs and eliminate the use of so-called Walton zero-gift GRATs.
- •The proposal would impose a 90 year limit on the GST exemption for so-called generation skipping or dynasty type of trusts.
- •The proposal would allow a gift tax annual exclusion maximum of $50,000 per donor without any present interest requirement. In effect, this would limit the use of so-called Crummey powers when making gifts to irrevocable trusts.
Impose Capital Gains Tax on Bequests at Death and Gifts in Lifetime of Capital Assets
- •The Administration’s proposal would make gifts and bequests of appreciated assets to non-spouses realization events for federal capital gains tax purposes. Capital gains would be triggered on asset appreciation at the time of gift or estate transfer rather than when the recipient later sells the asset. The recognized capital gain would be taxed to the donor in lifetime or to the decedent’s estate at death. The proposal essentially eliminates stepped-up basis at death. It would also accelerate the payment of capital gains taxes on gifted assets since the taxable event would occur on the date of the gift.
- •The proposal would allow a $100,000 per person exclusion of capital gains recognized at death and would be indexed for inflation after 2017. The exclusion would be “portable” to the decedent’s surviving spouse under the same rules that apply to portability for the current $5,450,000 estate tax exemption. This effectively makes the capital gain exclusion $200,000 per couple.
- •In addition, there would be a $250,000 exclusion for capital gains on a residence which would also be portable to the decedent’s surviving spouse. This effectively makes the exclusion $500,000 per couple.
- •For married couples, no capital gains tax would be due on assets given to a spouse or bequeathed to a spouse until the spouse disposes of the assets or dies.
- •Capital gains tax would not apply to bequests and gifts to charitable organizations.
- •The Administration’s would limit high-dollar retirement plans and IRA contributions and accumulations. The proposal would limit the combined maximum value of qualified plans, IRAs, 403(b), to about $3.4 million. This is the current actuarial equivalent to the indexed $210,000 annual defined benefit plan limit. Once the $3.4 million combined limit is reached, then future contributions would no longer be permitted.
- •The proposal would allow all inherited qualified plan and IRA balances for non-spouse beneficiaries to be rolled over within 60 days. This rollover would be to a non-spousal inherited IRA only if the beneficiary informs the new IRA provider that the IRA is being established as an inherited IRA. Under current law, non-spouse inherited IRAs can only be accomplished by a direct transfer between providers and not via a rollover.
- •The proposal would generally require non-spouse IRA beneficiaries to take all taxable inherited distributions within 5 years. The non-spouse beneficiary would typically be an adult child. Certain classes of beneficiaries would be allowed a life expectancy payout (i.e. disabled, chronically ill, a minor child). The current rule allows a life expectancy payout for any non-spouse beneficiary as long as the first distribution is made by December 31st of the year following death.
BSMG will keep you informed of any tax reform legislation which has the possibility of being passed by the Republican Congress in 2016. Of course, President Obama may veto any Republican crafted tax legislation and the Congress will probably not have the 2/3 required majority to override any veto. Once the Republican and Democrat presidential candidates are determined after the primaries and caucuses of the 50 states are completed in June, BSMG will provide a side by side comparison of their tax reform proposals.
Russell E. Towers JD, CLU, ChFC
Vice President – Business & Estate Planning
Brokers’ Service Marketing Group